Figuring Out A Debt Strategy After The Home Purchase

My wife and I have spent extensive time thinking about a plan for repaying all of our debts after we move into the home. Our goal is to be debt free (including the mortgage) in fifteen years – a goal that my wife heavily believes in. For me, although I don’t believe it maximizes our dollar, I do believe that it’s a great goal that will enable us to be debt free when we reach our 40s and we start focusing on paying for our children’s college education.

The Basic Debt Snowball

Our basic debt snowball is pretty straightforward. Our only debts outstanding are three student loan debts, two of which have an interest rate higher than our home loan and one with a very low locked-in rate lower than our home loan. So, our first goal will be to pay off the two higher ones, followed by the mortgage, followed by the smaller one. With focus, the two higher ones should be paid off in a year or so – this will be easier because we’re no longer saving every spare dime for the down payment and moving expenses.

So, our first draft of the plan is:

Pay off student loan debt #1
Pay off student loan debt #2
Pay off mortgage
Pay off student loan debt #3

Unfortunately, it’s not so simple…

Issue #1: Emergency Fund

Right now, we have about three months’ worth of my salary in an emergency fund. I would like to have eighteen months’ worth of my salary – or about twelve months worth of our combined salary – in that emergency fund. To me, this is a very high priority, higher even than the debt snowball. I don’t wish for a bad situation to derail my family’s plans – right now, I have a toddler and I have a baby due in three months, and my children and my wife are the center of my life, period. So, an emergency fund is an even higher priority than the debts.

So where are we at?

Build a twelve month emergency fund
Pay off student loan debt #1
Pay off student loan debt #2
Pay off mortgage
Pay off student loan debt #3

But wait, there’s more…

Issue #2: Automobiles

My wife and I both have cars between five and ten years of age that are fully paid for. We both plan on driving our automobiles until they literally die on the road or another social change makes a new one necessary (like a possible third child…). We anticipate needing one new vehicle in three years and another one in five years. We plan on buying well but not luxury – our tentative plan is currently to buy a minivan and a sedan (yes, we’re about as boring as possible). We’re willing to pay more for reliability but we don’t need most of the hallmarks of quality – these will be family vehicles, like a Honda Odyssey and the like.

So how will we pay for these? I would prefer to pay cash for them if at all possible, so that basically means if I start making payments on them now, we can afford to outright buy them in three years. To ballpark it, I looked for prices on late model used versions of the auto models we’re looking at, then worked out a three year payment plan on one and a five year plan on the other using an online loan calcuator (my “payments” now are lower than they would be if we bought it on a payment plan, because I’m not paying interest and the savings account is earning interest). Those features add together to trump any of our current debts and also even to trump our large emergency fund buildup.

So, here’s the real savings plan for now:

Car fund #1 ($501 a month gets us $20K in an HSBC Direct account in three years)
Car fund #2 ($289 a month gets us $20K in an HSBC Direct account in five years)
Build a twelve month emergency fund (this basically catches all the extra for the next few years)
Pay off student loan debt #1
Pay off student loan debt #2
Pay off mortgage
Pay off student loan debt #3

Some Thoughts

It’s kind of disappointing that we’re not immediately paying off debt. However, in the case of the car funds, we effectively are paying off debt – without those funds, we wouldn’t have the ability to just write a check and replace our old, worn-out automobiles. The $20K estimate might be high for a late-model used, but I’d far rather have too much than not enough.

What about the “tight budget” effect? I’m not really worried about it, to tell you the truth – I like it if the budget is tight right now because it encourages me to be careful and frugal. I don’t stay up at night worrying about it because I know that we do have cash, but I also know that there’s only a small amount of free spending money right now, so I don’t buy frivolous stuff.

Why do this? By building a master plan like this and carefully planning ahead, it’s going to make our financial situation as our kids grow up much better. Right now, we can quite easily make frugal choices – our children will be quite young and won’t have expensive needs. But by laying the framework now, we’ll have a lot more cash freed up in fifteen years when our children are starting to look at college – we’ll have 529s for both of them and no debt at all so that if we make the decision to help more, we can.

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